By Tim McLaughlin, Senior Vice President, Weichert Financial Services
Tuesday, August 2nd is the expiration of the current “debt ceiling” limitations, and with under five days remaining to get a new agreement in place, the market continues to get more and more nervous about the potential repercussions with Congress and the President continuing to have multiple proposals by no clear cut solution.
There are two main issues surrounding the debt ceiling crisis. First is the issue of potential default (or delayed payment) by the US government on its obligations. Obviously if the government doesn’t have the funds to make payments, it needs to borrow funds. If the debt ceiling is not increased, it has no ability to do so. The second issue is the possibility that S&P and/or Moody’s would downgrade sovereign US debt, which could have a ripple effect in our financial system.
At the root of the debt ceiling debate is the massive budget deficit (currently about $4T/yr). The pace at which we reduce the budget deficit will directly impact the pace of future debt ceiling increases. The rising Debt to GDP ratio is one of the primary causes of potential ratings downgrade.
Clearly the best case scenario is for Congress to quit the ongoing political game of chicken and come up with a plan to reduce the budget deficit and increase the debt ceiling. If they do NOT do so by the August 2nd deadline, does that mean there will be a default? Technically, the government could hold back (delay) payment of operating expenses, such as Social Security, Medicare, or government contracts. While this might not technically be considered a default, it is most certainly a very dire circumstance that could be met with a downgrade of debt ratings.
If Congress doesn’t raise the debt ceiling in time, is there anything the President can do? Some experts say that Obama can unilaterally raise the debt ceiling under the 14th Amendment of the Constitution, citing the validity of the nation’s public debt “shall not be questioned.” Even if this is possible, it would clearly only be a short term fix and doesn’t address the underlying issue.
Could the US just print more money to pay its bills? They could….but it would just further devalue the currency and cause more domestic inflation. As such, this is not a long term solution, and doesn’t mitigate the risks of a ratings downgrade.
The biggest focus for us is what will this do to a volatile market environment over the next few days/week? A default and/or downgrade could have impactfully negative consequences on interest rates, particularly mortgage rates. Additionally, what would this do to the Equities markets, which in turn impacts both the employment sector and consumer confidence.
Expect choppy market conditions over the next week or so.